Abrupt Fall From Grace

In a mid-sized conference room at the Taj Palace Hotel in New Delhi, a group of participants are in a workshop on social entrepreneurship in India. The people in the room include foreigners and Indians in equal number, all of whom are at the World Economic Forum's India Economic Summit. They are listening avidly to a blue kurta-and-trousers-clad speaker talking of his passion: microfinance, and its potential in lifting people from poverty. This is circa 2008, and Vikram Akula, who runs one of the best-known microfinance companies in India, SKS Microfinance (which he founded in the late 1990s), has his audience hanging on to his every word.

ALITTLE more than 18 months later, SKS went on to become one of the most storied initial public offerings (IPOs) in recent history. The stock listed in August 2010 at Rs 1,036 (offer price was Rs 985); the roughly Rs 1,600-crore issue was oversubscribed more than 20 times.

But just a few months later, in October 2010, the company was hit by a series of setbacks; murmurs about suicides of microfinance borrowers in rural Andhra Pradesh began to make headlines in the local press, and SKS featured prominently in them, along with other companies. Then, there was the unceremonious sacking of CEO Suresh Gurumani — Akula had earlier become non-executive chairman — that raised a number of eyebrows.

In October 2010, the Andhra Pradesh government issued the Andhra Pradesh Microfinance Ordinance — which was passed as an Act by the Legislative Assembly in December 2010 — that severely hampered the company's operations in the motherland of microfinance by putting several restrictions and conditions on the conduct of business.

SKS is not only India's most high-profile microfinance institution, but in public perception, it is also the leader and the proxy for the microfinance industry in India — at least the avatar of microfinance that we have currently. It has a charismatic leader who has been featured in Time magazine; the firm was expected to change the nature of how the poor are financed.

Some of the biggest and most professional investors have put money into it. The controversies and the decline of SKS is a cautionary tale of how a great dream is on the verge of crumbling. Which brings us to the present.

Bad Portents
In May 2011, a report by equity analysts at JP Morgan Asia Pacific Equity Research downgraded a stock that was already under pressure and reduced its value to half the listing price ahead of SKS's fourth quarter financial results. The report argued that most of the AP loans — the AP book, that is — was seriously impaired and that the company would have to take losses (the state's ordinance said collections could be made monthly but not weekly, restricting the flow of the business's lifeblood). 

A similar report from Credit Suisse suggested that the performance in the fourth quarter — and the losses — could stretch through 2011-12 (FY12). Other analysts we spoke to went as far as to say it could go into FY13.

Some say that a large part of the SKS story remains untold. "The latest developments are an unfortunate confluence of circumstances, but perhaps inevitable," says the head of a leading investment banking firm. "Reconciling the rhetoric of poverty alleviation through microfinance with the commercial success and a few people getting very rich is going to be a mammoth task."

Our attempts to speak to Vikram Akula and other company executives met with no success. We were also unable to get in touch with the private equity firms and initial investors in SKS  before it was listed.

The speed at which the SKS success story unravelled has raised several questions. First, was Akula's revolving door entry and exit as chief executive sensible? Second, does his leadership style — some people we spoke to called it "arrogant" — cause more harm than good? Third, will the Andhra Pradesh Microfinance Institutions (Regulation of Moneylending) Act 2010 strike a body blow that the company will take time to recover from? Fourth, what will the future be like for SKS Microfinance?

break-page-break
Akula's ‘here-again, gone-again' approach to running the company he founded has had critics carping. He took breaks to complete his PhD from the University of Chicago, then went to work at McKinsey as a consultant in the US, and thus the analogy to the revolving door.

"It's almost as if his attention span was limited," says one critic. But to be fair to Akula, he was also dealing with difficult personal circumstances that included a tough divorce (his ex-wife is American); the situation required his presence in the US a lot of the time, and may have affected his ability to run the company.

When Akula spoke to BW just before the IPO, he said he got out of doing the CEO's job because too many startups had failed because of the CEO. "I want to make sure that this company does not fail, I want this company to be able to put as much money in the hands of as many poor women as possible," he said then.

Some have questioned his ability at business execution. The organisation was built and managed by people such as the late Sitaram Rao, Y.V. Raghunath Reddy — now a project officer with the AP government working with self-help groups (SHGs) that the state uses to disburse its funds along the lines of the Grameen Bank model, and for whom microfinance companies are competition — and Praseeda Kunam (who runs her own NGO, Samyatha, in Madhya Pradesh) as chief operating officers. But there is little doubt that as an ambassador for the microfinance industry, Akula is almost without peer.

When Rahul Gandhi made what may have been his first visit to AP in 2006, he sat in on one of SKS's community meetings in a village. Political analysts in Hyderabad say the unexpected event rattled the state's Congress government, who were unaware of Gandhi's plans. They also say Gandhi's visit may have been facilitated by a Congress leader, V. Hanumantha Rao, who also happens to be Akula's uncle.

LOOPHOLES: Questions have been raised over lack of transparency in the governance of the mutual benefit trusts, where the beneficiaries were the women borrowers and which own about 12 per cent stake in SKS Microfinance (BW pic by Amit Verma)

The Consequences Of Commercialisation
His ability to attract the finances (in the form of grants) that SKS needed when it was still an NGO, and to bring in the likes of Vinod Khosla, former CEO of Sun Microsystems, and other Silicon Valley millionaires of Indian origin — people of modest beginnings who made it big in the software industry — as investors in a social venture have been widely acknowledged.

"The second round of investors (mainly private equity investors) was another story altogether," says M.S. Sriram, professor at Indian Institute of Management, Ahmedabad, who has worked on microfinance issues for a long time (he now works on banking). "Private equity firms bring standardisation to the engagement when they go in for scaling up, and that may not meet the changing needs of the borrower."

The Gurumani sacking barely two months after the highly successful IPO debut brought Akula back as executive chairman of SKS, but the incident left a sour aftertaste. The sudden wealth that the SKS IPO created for company executives, mainly Akula and Gurumani, through employee stock options or ESOPs, also raised a number of hackles in AP, with many politicians suggesting that these riches were made on the back of the state's poor people who saw no tangible benefit.

"It appears to be a simple matter of greed," says another leading investment banker who also did not wish to be identified. "There is no reason not to have let Gurumani go after he exercised his stock options that were due to him anyway." Yet, Akula's public pronouncements have always focused on the social good that he makes his mission, of using microfinance to lift people out of poverty.

"Poverty alleviation as a goal is philosophically confusing," says P.N. Vasudevan, managing director of Equitas Microfinance in Chennai. "Or should we be talking of providing access to credit on a fair and transparent basis?" The other philosophical confusion, says Vasudevan, is between whether it should be done on a non-profit or a for-profit basis.

break-page-break
The Business Model in Transition
In his PhD thesis on microfinance at the University of Chicago, Akula seemed to criticise the for-profit model for microfinance as being almost immoral or unethical. But in his book, A Fistful Of Rice, he seems to have reversed his position, talking about how the commercial model of microfinance (in other words, for-profit) could eradicate poverty.

"There are two basic models that deliver financial services to the poor," explains Suresh Krishna, managing director of Bangalore-based microfinance company Grameen Financial Services. "There's the SHG approach, which is a developmental model; and the Grameen Bank model, wherein credit is made available on commercial terms." While the SHG model uses government money (unlimited resources), the Grameen model has capital constraints.

Originally, SKS was more like a mutual benefit society that ran on grants. The initial capital came from foundations and perhaps retail donations from US-based friends of Akula's. But to scale up, the company needed to become an NBFC, and that required Rs 2 crore in capital.

The internal accruals already present in the then five branches of the co-operative (they became mutual benefit trusts, or MBTs, where the members and beneficiaries were the women borrowers) was reinvested in the capital of the NBFC. Private equity firms then got interested, mainly Sequoia Capital and Sandstone Capital, among a few others.

What has excited the company's critics is what they claim as lack of transparency in the governance of the MBTs, which own nearly 12 per cent of the company's stock. "There is no clarity on the benefits to the beneficiaries of the trust," says one. "How are the proceeds from the offer for sale that was part of the IPO being distributed?" Readers may recall that along with a fresh issue of shares, some of pre-IPO shareholders of SKS sold parts of their stakes in the IPO as well, including the private equity firms.

Trouble In Paradise
But the troubles would begin soon. A spate of suicides — supposedly triggered by the coercive collection practices as claimed by the AP government — was blamed on the microfinance industry. High-profile SKS was a major target.

The intense competition among MFIs in the state highlights one critical fact: the population in the state is among the most indebted in the country, and multiple lendings abound. "If you look at the Reserve Bank of India's (RBI) reports, the credit deposit ratios, particularly in the rural parts of the state, are among the highest," says Sriram.

It also seems clear that borrowers have multiple MFIs to borrow from, and do, without the collateral ability to repay. "People borrow from one MFI to meet the repayments from the others," says one official. He suggests that as a possible reason for the suicides.

But is that enough reason for enacting a near-draconian law? The state government has said that it had written to the RBI thrice during the tenure of the Rosaiah government, but received no reply regarding how MFIs are regulated. So it took the law into its own hands, so to speak.

The result has been a near-freeze on the activities of SKS in AP. As mentioned earlier, the company posted a loss in the fourth quarter results, and stock analysts are bracing for more losses to follow. About a fourth of the loan book, or roughly Rs 1,000 crore, is AP-based. If a significant portion of that is written off, it could dent the company's net worth severely, and the stock fell on the exchanges on the news.

AN UNFAIR LAW?

HARSH VIEW: After 30 suicides in 45 days in Andhra Pradesh by microfinance borrowers, the then chief minister, K. Rosaiah, called a special meeting in October 2010 and issued an ordinance to rein in MFIs (BW pic by B.K. Ramesh) When the Andhra Pradesh government first issued its ordinance in december last year, which later became the Andhra Pradesh Microfinance Institutions (Regulation of Moneylending) Act 2010, the first reaction was one of dismay. The business of MFIs would take a big hit, because without the ability to collect dues every week, the money flows for a very cash-dependent business would dry up. There were various other restrictions such as that MFIs must meet the borrowers in a government facility such as a village panchayat office. What AP does matters, because it is the largest MFI market (if one can call it that) and where microfinance in its current form originated, accounting for nearly half of the loan portfolios of the entire sector. Some estimates suggest that 80 per cent of the entire country's portfolio is held by Hyderabad-based companies; any problems with them would hurt business all over the country. The law is almost an exact copy of the October 2010 ordinance, the preamble of which stated that the intent was "to protect women self-help groups" who were being exploited by private microfinance companies through usurious interest rates and coercive means" that ostensibly led to numerous suicides. The dismay is at the presumed guilt of the MFIs, which seems rather unfair. How usurious are the interest rates? With a cost of capital at 11 per cent, operational costs of 6 per cent, head office costs of about 1 per cent, branch costs of about 4 per cent, and loan loss provisions of about 1 per cent (totalling 24 per cent), adding a spread of 3 per cent (roughly what the banking system adds), it does not seem usurious. But the AP government disagrees.

Where will the company get the capital to carry on operations elsewhere in India? "On-tap securitisation is one possible solution," says Abizer Diwanji, head of the financial services practice at global consultancy KPMG. "Lenders for commercial vehicles use this already. The company keeps the collection risk, and passes on a part of the spread to the buyers of the securitisation programme." On 19 May, SKS CFO Dilli Raj said that the company had securitised a part of its non-AP portfolio to raise Rs 600 crore.

SKS and other MFIs may have gloried in the competition they brought in giving the unbanked poor access to credit in a way unimagined before. In most cases, even this one, that competition may be a good thing. But they will do well to remember what happened to the short-term personal loan market in 2006-08.

In the early part of the last decade, and until 2006, GE Money and Citicorp were the market leaders, amounting to about Rs 7,000 crore. In 2006, seven or eight new players entered and the market share jumped to Rs 17,000 crore. In 2008, after multiple lendings led to extraordinary defaults, the industry collapsed, and disappeared. If the same happens to the microfinance industry, it would be a pity.

srikanth(dot)srinivas(at)abp(dot)in

(This story was published in Businessworld Issue Dated 30-05-2011)